Trade World Series: EU 2, U.S. 0

July 05, 2001

If we tracked trade disputes like baseball, this contest could be a World Series in which the Europeans lead the U.S., two games to none.

They just don't come any bigger than the fight between this country and the European Union over a corporate tax break granted American exporters that the World Trade Organization has twice ruled illegal.

If this isn't resolved, it could lead to the EU leveling $4 billion--or more--in sanctions against the U.S. That, U.S. Trade Representative Robert Zoellick has warned, "would be like using a nuclear weapon" on the world's trading system. The results would be devastating.

The issue is this: U.S. companies making goods to sell abroad are allowed tax rebates under U.S. tax law if those goods are sold through offshore subsidiaries based in such tax havens as the Virgin Islands. Thousands of multinational companies like Boeing, Caterpillar and Microsoft benefit from this tax break.

Responding to an EU complaint, the WTO last year ruled this amounted to an illegal subsidy and gave the green light for the Europeans to slap $4 billion in sanctions on American companies--unless the U.S. changed the law.

Congress did just that in the waning days of the Clinton administration, but not as the Europeans hoped. The new law did away with the requirement that companies set up foreign sales subsidiaries and expanded the tax break so that more corporations qualified. What had been a $4 billion tax break for U.S. exporters grew to $6 billion.

Because of that, it surprised no one that the EU cried foul and went back to the WTO, which now has ruled again that the U.S. is in violation.

At this point, none of the U.S. choices in this dispute is pleasant. It can--and almost surely will--delay the day of reckoning by appealing, but ultimately this issue must be resolved.

The U.S. either must give up this tax break, substantially alter it, or negotiate a settlement with the EU.

Some on this side of the Atlantic would like the U.S. to file countercharges at the WTO against the EU, arguing that the current American tax law is not so dissimilar from tax schemes in many EU countries. That, however, would only add to the rising trade tensions between the world's two behemoths of trade, Europe and the U.S. Those tensions have already been exacerbated by the EU's decision to bar GE's proposed purchase of Honeywell on the grounds the merger--already OKd by U.S. regulators--would violate European antitrust laws.

The U.S. has much to gain from building the case for further expansion of world trade. It has much to gain from resolving this difficult dispute in a way that bolsters the WTO. It has much to lose by using the WTO to engage in a tit-for-tat trade war with Europe.

Zoellick and his EU counterpart, Pascal Lamy, succeeded earlier this year in resolving a long-simmering trade dispute over bananas. This one is a lot bigger than the banana wars. It will test all of their negotiating skills. But it will be worth the trouble if they succeed.